Tradability

Clearly, ETFs offer some advantages relative to mutual funds when it comes to how they can be bought and sold. A mutual fund (as opposed to a closed-end fund) has to be purchased from the investment company and sold back to the company. Therefore, if you own Fidelity's Equity-Income Fund, which you bought from Fidelity, you must contact Fidelity and instruct them to redeem the shares when you are ready to sell.

The pricing of mutual funds occurs once a day, at 4 p.m. when the markets close. If an investor desperately wishes to liquidate a mutual fund position at 10 in the morning, he or she is out of luck. The market may decline 500 points between 10 a.m. and 4 p.m., but there is nothing you can do. Conversely, the market may rise 500 points in that time, but you can't buy into the fund at that point.

It is also clearly the case that investors can buy ETFs on margin, thereby magnifying their potential gains. Of course, the potential losses are also magnified. Regardless, this cannot be done with mutual funds.

A significant advantage of ETFs is that they can be sold short if an investor anticipates a decline in the market or a particular sector. A short sale is a bet that the market price will decline. Just as investors buy funds if they expect the market to go up, some investors would like to be able to short funds when they expect the market to decline.

Because ETFs are, in effect, like any other stock, they can be sold short. In contrast, if you are strictly a mutual fund investor, it will be difficult to invest on the basis of a predicted market decline. A few funds cater to such a strategy, but they are relatively rare.